Markets X-factor has a clear mission

Butting heads: Chi-X Australia’s chief Peter Fowler.In the early 1990s, Peter Fowler was living in Sydney and working for one of the biggest stock exchange ”clearing houses” in the world, the London Clearing House, controlled by six British banks.
Nanjing Night Net

He had started off in the world of IT in London but moved here when LCH asked him, in the mid-1980s, to help them set up new markets for the business in Australia.

But a few years later, when the banks decided to pull out of the country to focus on Britain’s closer ties with Europe, it became his job to shut down parts of the business.

That’s when he decided he didn’t want to work for big banks any more. ”At the end of doing that, they asked me if I’d like to go back to the UK, but my family was well established here, so I declined the invite,” Fowler says. ”So I went out and started my own business.”

The business he started built the clearing system for equities the Australian Securities Exchange still uses.

Fast forward a few years, and Fowler is now the chief of Chi-X Australia, the first company to break the ASX’s monopoly on the domestic trading market. As we speak, he’s in the middle of a fantastic brawl over the future structure of the country’s trading market.

On one side sits the ASX, which is desperately trying to keep control of its monopoly settlement and clearing businesses.

(”Settlement” is the delivery of securities from one party to another. ”Clearing” refers to the process whereby trades are settled in accordance with market rules).

On the other side sits Chi-X, the upstart exchange that’s happy to rattle the cage. (Chi-X broke the ASX’s monopoly on share trading when it began operating late last year).

Encircling the fight, with shaking fists, are Australia’s other market participants: institutional funds, large trading desks, stockbrokers and shareholders, each with their little piece of flesh in the game.

One of the arguments at the centre of it all has to do with the ASX’s monopoly power.

”There is a fair amount of bad feeling in the market because of the high ASX charges,” Fowler says. ”The ASX makes a fantastic profit margin by normal commercial standards, and they can afford to do that because they’re running monopolies.”

It’s an unsettling time for the industry. The sharemarket has tracked sideways for several years as investors have increasingly shunned volatility to put more money into bonds and bank deposits.

There’s so little interest in the market, stockbrokers are losing their jobs, and small broking firms have begun to merge. Part of the problem is that volatility has declined to the point where there are too many stockbrokers trying to serve a dwindling pool of clients.

That was one of the reasons the ASX reported an annual profit decline last week. Its net income in the year to June 30 was $339.2 million, a decline of 3.7 per cent.

The chief executive of ASX, Elmer Funke Kupper, told shareholders market conditions had become progressively worse through the year as retail and institutional investors became more concerned about events in Europe and the US.

Three of ASX’s key business units – listings, cash market (equities trading), and information services – had recorded falls in revenue in the past 12 months.

Rumbling along behind it all, the Council of Financial Regulators has been considering whether the clearing and settlement structure for the Australian market is appropriate, and particularly whether the ASX’s clearing monopoly should be opened to competition.

At the moment, Chi-X operates only in the ”trade function”; it doesn’t run any post-trade services, such as clearing and settlement facilities.

But that means it has to pay $275,000 a year to the ASX for the right to use the ASX’s monopoly clearing service. And on top of that, every trade must pay a clearing and settlement fee.

Mr Fowler says he is keen to see ASX’s clearing service opened up to competition, because that would give Chi-X a choice about where it directed its clearing business.

”[But] there shouldn’t be competition in the settlement space,” he says. ”There should just be one settlement facility and it should not be run by a for-profit entity without having appropriate controls that deal with pricing, and fair and equitable access.”

”[And] if we had competition in clearing, with multiple clearer facilities, connecting to a single settlement facility, then we must have arrangements in place which ensure that all of those clearing facilities are treated equally. We can’t have the ASX favouring its clearing business while disadvantaging its competitors.”

But the ASX, for its part, has been warning regulators to think twice before opening up its clearing service to competition.

Just last week, Mr Kupper voiced concerns about the level of fragmentation in the Australian market, warning of the consequences of too much liquidity moving away from a single ”lit” market into off-exchange areas called dark pools.

He said if the ASX’s clearing and settlement services were opened up to competition, that would damage the market further.

Asked about Chi-X Australia’s performance since it began operating late last year, Fowler says the company has grown at a faster rate than some of its foreign peers.

He says it is doing better than its European, Canadian and Japanese peers had done at a similar stage.

But according to Deutsche Bank research, that’s not necessarily the case. The financial house published a report in May that compared the rates of growth of Chi-X’s global businesses after its first six months of trading in a new foreign market.

After six months of trading in London, Chi-X’s total share of market turnover was 8 per cent. In Canada and Germany, it was a bit over 6 per cent. But in Australia, it was just 1.7 per cent. And after nearly a year, it’s still only about 3 per cent.

Analysts say the growth in Chi-X’s market share in Australia has lagged the experience in other markets. But there are important reasons for that.

First, there’s less financial incentive for market participants to shift from the ASX to Chi-X because the difference in the fees they charge is much lower than in other markets. There’s also little difference in technology between the two.

And the fact that Australia doesn’t have competing clearing services is a big deal.

That goes some way to explaining why Chi-X is calling so loudly for Australia’s clearing services to be opened up to competition: if clearing services were competitive, thus reducing clearing fees, Chi-X would, in theory, attract more volume and more market share to its trading business.

And that would help Chi-X twice, by reducing its costs and by stripping revenue from its competitor, ASX.

”But the main benefit for Chi-X would be that it would help with their market share,” Kieren Chidgey, a Deutsche Bank analyst, says.

Fowler says it’s OK that Chi-X is not used as the benchmark index.

”In terms of the newspaper coverage of the equities market, it’s the ASX brand name that is commonly used. We won’t be able to change that default behaviour until our market share grows,” he said.

”In Europe, what is now called BATS Chi-X Europe trades over 30 per cent of the London Stock Exchange [LSE], but still people will talk about the ”LSE prices”.

”So the change to the mindset is going to be a very slow, gradual task. And that’s OK.”

This story Administrator ready to work first appeared on Nanjing Night Net.